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Instant Income With a New Covered Call on Cisco Systems

The S&P 500 enjoyed a nice rally during the first half of this week thanks to the bullish performance of technology stocks. Though it pulled back yesterday, the index managed to close above 2,900, which we think is a good sign.

Because tech companies generate so much revenue in China, these stocks have been especially sensitive to trade negotiations between the United States and China. So, when the Trump administration started hinting at improvements in trade negotiations this weekend, traders started buying stocks in the tech sector again.

This move back into tech stocks has been good for our long stock position in
Cisco Systems
(NASDAQ:
CSCO
), but we don’t expect it to reverse its bearish downturn yet. It will take a more than a noncombative tweet from the president to convince Wall Street to buy CSCO with both fists again.

In fact, the news on trade is still somewhat mixed. The White House is apparently considering reversing some of the
tariffs on Chinese goods
, but the president has also said he’s “
not ready
” to make a trade deal yet.

But that’s just fine by us. The price action on CSCO gives us a great opportunity to generate some instant income by selling a covered call, and there’s a high likelihood we can do the same thing again next month.

Dropping After Earnings

CSCO dropped through support just above $51 after the company reported worse-than-expected earnings on Aug. 14. Analysts had expected the company to report earnings of $0.73 per share, but CSCO only reported earnings of $0.51 per share, missing estimates by $0.22.

This drop completed the formation of a “symmetrical triangle” bearish continuation pattern and confirmed Wall Street was ready to take some profits off the table after a multi-year bullish run for the stock.

Daily Chart of Cisco Systems (CSCO) — Chart Source: TradingView

After dropping, CSCO seems to have found solid support just above $46. The stock bounced up off this support level previously in early February. The support bounce we have seen so far is great, but we don’t think it is going to be strong enough to completely fill the bearish gap that formed after the earnings miss.

A Deceptive Chart

Now, if we were just going to be holding onto the stock and doing nothing else, this chart might look a little depressing. However, since we’re only holding the stock so we can sell covered calls against it and generate income, this chart looks amazing.

Why? It gives us the perfect price level to set our strike price for our covered call.

As we work with CSCO in our portfolio, we want to be able to generate instant income using the stock, but we don’t want the stock to be called away from us yet. The only way the stock will get called away from us is if the stock price rises above our strike price and the call option buyer decides to exercise the option.

So, if we can find a strike price the stock is unlikely to rise above — but low enough to offer an attractive premium — we have a high likelihood of being able to hold onto our shares of CSCO once the option expires worthless. That will then leave us in a position to generate even more instant income by selling another covered call against CSCO.

Looking at the chart of CSCO, we don’t think the stock is going to rise back above the former support level at $51 anytime soon. Instead, we think this price level is going to hold as a solid resistance level in the short term. That means it’s a great price level to use for our strike price.